Capital Gains Rules for Military Families

29 August 2016

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Note: this is not professional tax advice. While I have confirmed this information with various professionals, do not take my word for it. Read the tax rules yourself (link at the bottom) and consult with your tax professional to see how the rules apply to you.

When you’re in the military, one of the most confusing parts about being a homeowner is understanding when you’ll be subject to capital gains taxes on the sale of that property. The capital gains rules for military families are a lot more generous than the rules for civilians, recognizing the fact that military families don’t have control over their moving patterns.

Capital Gains Tax and Exclusion

When you buy a house, and later sell it, the profit is subject to capital gains taxes. There is an generous tax break available to everyone: if you live in the house for two of the five year prior to the sale, you can exclude up to $250,000 ($500,000 for a married couple) in profits from taxation. The two of five years rule is often called the “use test,” as it is establishing whether you used the property as your principal residence.

For example, Joe and Sally buy a house in June 2010, and live in it until December 2013. They then move into a new house and rent out their old house. In September 2016, they sell the rental house. By counting back five years from the date of sale (September 2011), you can see that Joe and Sally lived in the house for more than two years (September 2011 to December 2013) of the five years prior to the sale. They are able to exclude up to $500,000 in profits from being subject to capital gains taxes.

As another example, Erin and Paul buy a new house in December 2014. In December 2015, they have triplets, so they sell their house to purchase a larger house. Because Erin and Paul did not live in the house for two years, they will have to pay capital gains tax on any profit derived from the sale.

It is very important to note that you can not take the capital gains exemption more than once every twenty-four months. There do not appear to be any exceptions to this rule.

Suspension of Time for Military

If you are military on active duty and receive Permanent Change of Station (PCS) orders to a location more than 50 miles away from the property, you may “suspend” the clock on the two out of five rule listed above. The suspension may last no more than ten years, for a total lookback period of 15 years.

For example, Tom and Jennifer buy a house 2005, and live in it until 2010. They receive PCS orders across the country, and make their house a rental. In 2015, they decide to sell the property. They are eligible to exempt their profits by suspending the years 2013 to 2015, and showing that they lived in the house for two of the five years prior to the suspension (2008 to 2010.)

An easier way to look at this suspension is that, under typical circumstances, military families can exempt profits from capital gains if they lived in a house for two of the fifteen years before the sale, as long as they were not stationed within 50 miles of the property at any time and considering the following important detail:

Multiple Properties

It is very important to note that you can not suspend the time for more than one property at a time.

For example, let’s say that Matt and Melissa buy a house in Virginia in 2003 and live in it until 2007. They receive PCS orders to move to Florida. They rent out their house in Virginia, and buy a house in Florida. In 2010, they receive PCS orders to California. They rent out their Florida house and now have two rental properties. In 2016, they decide that they are tired of being landlords and sell both houses. They have not lived in either house for two out of the last five years, so they are not eligible for the regular tax exclusion on either property. They are, however, eligible to suspend the clock on ONE of their properties. They will have to figure out which property will get the most benefit from the suspension, and pay full capital gains taxes on the other property.

The Tax Is Only On The Profit

Don’t forget that the capital gains tax is only paid on the net profit made from the property. This includes the original purchase price of the property, plus any capital improvements that have been made to the property, selling costs, and selected purchasing costs. Great record-keeping pays off when you are calculating your gain.

Selling After Leaving The Military

There is a vague and poorly explained rule that says that ” This extension of time can apply to taxpayers who have recently left the military.” Unfortunately, it doesn’t say when it “can” apply, or how “recently” you must have left the military. If you’re planning ahead, you’re going to want to talk to your tax strategy person and figure out what the IRS might mean by that law. If you’ve already sold after retirement, you’ll have to guess whether you think this language fits your situation. You can find the actual language in the first highlighted block on page 11-18 at https://apps.irs.gov/app/vita/content/globalmedia/4491_capital_gain.pdf.

There are various things you can do that may reduce the tax liability on the sale of a rental property, including deferring the taxes by purchasing another property in a 1031 tax deferred exchange, or by living in the house for a period of time before selling. There are tons of resources available to explain these, if you are interested.

The application of the military suspension for the calculation of the use test is very misunderstood. I have seen many people claim that it means that you have to live in the house for two out of ten years, or other misinterpretations of the law. You can find the exact explanation and example in IRS Publication 523, Selling Your Home. The examples in Pub 523, particularly about the military suspension, are very helpful in understanding how the written rules actually work.

If you have questions, or you think I’m confused, or you have experience that would help others, please comment. Understanding these rules can have a big impact on house-selling decisions and the choices you make can save or cost you a lot of money.

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Comments

My question is this: we are a foreign service family and bought our house in 2006, and lived in it until 2009, before going overseas for the dept of state from 2009 – 2015. We rented out the house during this period We then sold the house in 2015. We understand we can claim the house as our primary residence and hence pass the 5 year test. However, do we have to pay capital gains for the portion of time the house was rented out (i.e. 6/9 of the time we rented out the house?) or is the entire capital gain (up to 500,000) exempt from capital gain because 2009-2015 is “suspended”? Thanks! JJ

Ps I do realize we are on the hook for depreciation recapture and of course, paid taxes on the actual rental income.

JJ, I don’t see that I replied to you. I apologize! As I read the rules, you should be in the clear for capital gains. You resided in the house for 2 out of 5 (2007 to 2009 out of 2007 out of 2012) and you get a 10 year extension to 2022. Definitely consult with a tax professional that understands these rules.

Why does JJ get a 10 year extension? We bought a house in 2005 and lived in it until 2008. We lived in another state from 2008-2011, then moved overseas from 2011 until 2016. When must we sell our house to avoid the capital gains? Thank you!

The residency requirement is two years. The last two years you lived in the house were 2006 to 2008 (you’ll have to figure the months.) Then, count the two out of five, so 2006 to 2011 would be the five year limit. Military get a 10 year “suspension,” so you would have to sell in whichever month of 2021. I wouldn’t let it go that long, of course.

Be sure you also understand depreciation recapture – that’s likely to be a bigger tax hit anyway.

I appreciate your help on this. We are military, we just sold a house last year that I can claim as main house after meeting the IRS requirements easily. However, we also have a house in Kentucky and lived there from 2004 to 2011, we have been renting it out since 2011, but thinking to sell this year. I was little bit unclear when it involved two rental properties.
Thanks in Advance!

I have a unique case where I am able to take advantage of the 10 year exemption to avoid cap gains tax. Bought the house in 2004, lived in it until 2011 when stationed to DC. The house has been a rental since 2011. I am retiring from service on 6/1/17. Do I have to sell by my retirement date, or does the extension still stand.

Shelly, the extension can extend into retirement, but the IRS is shockingly (or maybe not shockingly) vague about details. Here’s the link to the place I’ve seen it referenced: https://apps.irs.gov/app/vita/content/10/10_14_010.jsp?level=advanced It is in the box below the regular text. I think it is up to your accountant and you to guess what the IRS might consider “recently.” I hope that helps.

For some unspecified period, yes. The IRS says that “The extension of time can apply to taxpayers who have recently left the military.” https://apps.irs.gov/app/vita/content/globalmedia/4491_capital_gain.pdf Page 11-18, the first highlighted block. It doesn’t define when it can apply, or “recently. Please get with a super-savvy tax preparer to put together a strategy.

Hi there. My husband and I purchased our home in WA in June 2015, we received orders to California for June 2016. We rented our the home this past year and our renters are leaving June 2017. Because of his military service, do we receive any exemption from capital gains tax on the sale of our home? We only lived in the residence for 12 months.

Caitlin, to the best of my knowledge, the capital gains extension does not contain any provision for not meeting the original two year rule due to military service. You will still be eligible for a pro-rated exemption based upon living in the house for the one year, so roughly half your capital gains will be exempt under the regular rules. It’s so rare to make a profit on a house in just two years of ownership, so you’re still coming out ahead even if you have to pay some taxes on the gain.

You will also need to pay for the recapture of depreciation taken during the time it was a rental property. Thankfully, that won’t be much because you only rented it for one year.

Congratulations on making any profit during such a short homeownership. You’re very lucky!!

You may, but it is unlikely. The capital gains exemption can be pro-rated in certain circumstances, including a work-related move. 21/24 of $250,000 per person is a lot of capital gains. Most people who sell within 21 months don’t make any profit at all, so I’d be surprised if you ended up owing capital gains tax. Your CPA can give you more information about your particular situation.

Hi Kate, My husband bought a home in 2006 and lived there until September 1, 2009 when he moved to go to school and rented the property out. In August 2012, he entered active duty service and has been stationed more than 50 miles away from the home throughout his service. He is still on active duty. We recently sold the home. Does that mean we can go back to August 2012 and use the 5 year test for prior to 2012? He lived there from August 2007 to August 2009 so we would be OK right? Thanks!

Probably June 2022. The regular 2 out of 5 rule would be 2012, as you lived in the house 2 years (June 2007 to 2009) out of the previous five years (june 2007 to June 2012.) The military extension allows you to “suspend” up to ten years. You will presumably suspend from June 2012 to June 2022, or whenever you sell. There are rules that could affect this, so you should consult with a tax professional to ensure that this is correct for your specific situation.

Hi there,
My husband and I are getting ready to close on the sale of our rental property. We lived in the house from Jan. 2009 to February 2012. We moved on PCS orders from WA to FL. The sale is scheduled to close on July 28th, 2017. My question is, what is the process of suspension and avoiding the capital gains tax? Is there anything I have to do before the sale closes, or does all the paperwork happen at the time we do our taxes?

Corinne, your tax preparer should handle this all when he or she does your 2017 income tax return. You might want to remind him/her of the military extension – I’ve heard that it isn’t very well known.

The state where the property is located may be a different issue. Some states require that taxes are withheld from the net proceeds of a sale. In some of those states, you can file for an exemption from withholding, or file for an early refund of the funds withheld. Your real estate agent and closing company should be able to explain this to you.

I bought a house in 2009 and revived orders and moved out side of 50 miles. This was 2011 I did not meet the full two years short by a few months. I rented it out till 2017 sold it for a solid profit. The question I guess can I file for the military extension and than file for partial capital gains exemption?

Justin, I always recommend that people who sell houses retain the services of a well-qualified CPA. I do believe you can file for the military extension, and then file for a partial capital gains exemption. Your CPA can also help you figure out the depreciation recapture and how to minimize your capital gain by accounting for all the allowable expenses. Great job making money during a time when many markets were tough!

We bought a home in WA in 2005, where we lived for more than 2 years. We then moved to FL under PCS orders and have been renting it out since then. However, in 2014 we moved back to the same area but continued to rent out the home. Can we still claim the capital gains exemption even though we currently live in the area?

We sold two homes last year. Both had been used as rentals. One was purchased by me before I was married and the other was purchased by my wife before we were married. I meet the 2/5 exemption rule for my house. When we got married in 2011, my wife moved in with me and we eventually rented her house. In 2013 we got PCS orders. If I can suspend the timeline for her from 2013, she meets the 2/5 criteria. Can we claim the exemption for both houses? Does the rental aspect affect the exemption?

We are active duty military and purchased a home in Virginia in 2003. We lived in the home as our primary residence until 2011 when we transferred to CA and rented our VA home to tenants. About 2 1/2 years later in 2013 we transferred back to VA and continued to rent the home out as we moved into a different home. We remained in Virginia until 2016.

In 2016 we transferred overseas and just recently sold our home in VA. Are we exempt from Capital Gains taxes on the profit of this home sale?

Hi! We bought a house in November of 2015. We decided to put it on the market because I’m deploying for a year and i wanted my family more stable. We are set to close on 13 October, 1 month shy of 2 years. We make about $2000 more than the 15% tax bracket.

We accepted a $360,000 offer on the house and am being told we will have to pay $12750.00 in capital gains taxes.

Are there any exemptions since we are only a month shy and $2K higher than 15%? And, can we deduct the costs of upgrades from the profit and pay less than $12750?

If not, is there an extension (tax free) on paying taxes since I will be deployed?

Ronald, these are questions that you should be asking an accountant. If you don’t have one, get one ASAP. You’ve got a lot of variables here, and I don’t have nearly enough information to answer your question, and it sounds like your understanding of the situation is pretty basic.

There is an extension on paying taxes due from deployment: https://www.katehorrell.com/tax-extension/ The math is a little tricky, but you can roughly guess that your taxes will be due six months after you return from deployment.

To anyone out there reading this: get an accountant before you sell your house. It is possible that Ron’s sales date is going to cost him a lot of money. Pre-planning is essential to a smooth and not-extra-expensive sales experience.

Good Morning. We bought a home in 2008. We lived in it until 2010 and then moved due to military orders. From July 2010 – April 2016 we rented the property out. In May of 2016 my wife returned to the home (and have been there since) while I served at an overseas location for 365 days. We will be closing on the sale of the house on 1 November 2017 (18 months since the home again became our primary residence). Will we have to pay full capital gains taxes on the sale? OR will we qualify for a prorated amount since we lived in it 18 of the 24 months prior to the sale?

Based upon the information you have provided, you should be eligible for the full capital gains exemption, suspending some years using the military extension. If you suspend the time from July 2010 to April 2016, you meet the two-out-of-five rule for the full capital gains exemption. Be sure to work with your CPA to ensure that he or she appropriately uses the military extension, and that you get the depreciation recapture right. It’s super-tricky.

Hi Kate,
We bought our house in San Diego on October 2008. We sold it when we moved overseas on April 2015. We made a profit from selling the house. Now we are moving back to San Diego in January. Are we going to pay taxes? Will buying a house the solution of not paying the taxes from the capital gains?

I would appreciate some clarification on my situation. I am active duty military and purchased a home in 2007 with the intention of getting out, then the economic crash happened so I decided to stay in. In 2009, I received orders overseas and moved. I did not return to the property, but started renting it out and pretty much kept it rented until I sold it. I just sold it this year after the market finally came back enough to where I could sell it for what I bought it for. After realty fees, closing costs, etc. I really made nothing on the property. I am worried that I’m going to get hit with a big depreciation recapture tax, and actually didn’t even know about depreciating it each year at tax time. In fact, I never claimed depreciation until last year. I have been told that in the year I sell I can claim all previously unclaimed depreciation using the IRS Form 3115. Will that make a difference… at least enough to offset the tax I’ll get hit with?

David, every individual situation is different. Based upon the information you’ve provided, you will probably owe depreciation recapture taxes even though you didn’t depreciate the property each year. The law is specifically written that depreciation recapture taxes are based upon “depreciation allowed or allowable.”

I’m unfamiliar with the use of the Form 3115 to claim all previously unclaimed depreciation. Perhaps your accountant knows something that I don’t know – I am not a tax professional.

Hi Kate! Questions for you because we are getting conflicting answers from a tax advisor (I don’t think she knows what she is talking about).
My husband bought a house in Vegas in 2010. We lived there until 2013 when we received orders to the UK for 4 years. For those 4 years we rented out our house. We recently returned to the US, however, to NC not NV. Our realtor recently helped us sell our home and we received capital gains on it. Will we have to claim those on our taxes? It was under the $250,000 profit and we did live in the house from 2010-2013. The CPA that my husband is in communication with claims that we will have to claim the gains on our taxes because we do not meet the 2 out of 5 year rule.
Just really confused on what we have to do. Is there a publication number that we can reference this on the IRS website?

Hi Kate, So here is my situation. Back in AUG of 2011 we purchased a home while I was on Active Duty. It is under my wife’s VA but both on title. We left on official orders to FL in OCT 2014. We bought a house using my VA, both on title, in FL in SEPT 2014, while renting the CA home until OCT 2017. We sold our FL home in OCT 2017 due to moving overseas on PCS orders. We are selling the CA home and due to close on Dec 15th 2017.

I meet the use test for regular tax exemption for the FL property obviously as it was our main home for the past three years. My question is can we use the suspension of the CA home in the same year as we sold the FL home? We meet the criteria, I believe. Reading your post on “Multiple Properties” got me to think it would be ok to suspend the CA home and take the exemption and take the regular exemption on the FL home. Does that make sense or would I just have to take the exemption on one of the homes?

I’m having a little trouble following your timeline, including when you bought the house in California, but I’m not sure it matters because I’m going to advise you to get a really good CPA. I don’t see anything the military extension that changes the rule that you can’t take the exemption on more than one property within a 24 month period, so I’m thinking you need to figure out the benefits of taking the exemption on each house and pick the one that will save you the most money. Good luck!

From what I took from your post on multiple properties that one could use the military extension and one could be taken as normal 2-5 rule.

We bought CA home in AUG 2011 and started renting it in OCT 2014 when we got orders to FL. When we arrived in FL in 2014 we bought. OCT 2017 we sold the FL home and this DEC we will have sold the CA home. Both home will be sold in 2017, but my question was could we avoid capital gain on both by the CA home having the military extension and the other being our main residence on what everyone gets from the 2-5 rule.

Kate – – Thank you for the above information! My question is this, we currently own a rental property in California that we lived in from Dec 2012 – May 2014 (17 months), and moved due to a PCS overseas and then to Ohio. We are looking at now selling this property around Mar/Apr 2018. That being said, would we have to pay capital gains since we only lived in the house for 17 months? As of right now, we are looking at selling for over 160-190K than our purchase price.

Hi there! Our situation is a bit different than all the above, wondering if you have some advice. In 2016 we were told we were going back to TN so we bought a house, two weeks after closing the military said ‘just kidding’ and there we were, stuck in a rental in VA, but proud owners of a home in TN that we would never live in. We were lucky to rent it out and now the tenants want to buy. We moved from the rental in VA and bought another house in MD (so we currently own two houses). The market in TN is hot so our house has gone up in value. If we sold it at a profit of say $15,000 (just guessing), will we get hit with capital gains? I feel like this situation was caused by the military but you can’t put that on your taxes, lol!!!

Yes, if you have a net profit on the sale, you will owe capital gains taxes. On the bright side, you will also be super-lucky, as very few people in your situation make a profit and a few taxes are a small price to pay for not losing money.

Hi Kate~
Here’s our situation: We purchased our home in WA while my husband was active duty in Sept2002. He received unaccompanied PCS orders in Oct2004-Nov2005. We then PCS’d overseas Feb2006-Dec2007. I moved back into home and he PCS’d to TN. (We got a divorce in Jul2008, but still kept the home together but rented it until we sold it a few weeks ago (Jan2018). My ex retired active duty in Mar2010 and immediately went DoD in DC. Are we eligible for the military extension because we/he lived in the home over 2 years while active duty and because all of his PCS orders were obviously over 50 miles. THANK YOU!

We purchased a house in Ohio in Aug 2011. We lived there until Jul 2014. Got PCS orders to CA but kept the Ohio property as rental for 3 years. We bought a house in CA in Sep 2014. We are selling the CA house in Spring 2018 due to PCS orders then buying another house in Northern VA. Will this be like kind exchange and would not need the capital gain tax rules? This is to enable us to use the capital gain tax exclusion on the rental that we have sold in Jul 2017. Are we unfortunate to fall under the only one tax exemption (capital gains) within 2 years?

If we have to pay capital gains on one of the sales, can you please explain deprecation recapture of rental property?

We PCS’d and bought a home in July 2011 this was supposed to be a min 3 year duty station, but my husband unexpectantly got new orders December 2012 and the family had to PCS across country again and were left no choice but to rent the house out, we listed it for rent January 2013 and didn’t get renters until March 2013 and it is still a rental and we are wanting to sell in 2018 but I have not been able to get a clear answer as to if we quality for a partial exemption on some of th capital gains tax since we were only in the house for 1 1/2 years, but we had no choice on moving due to PCS orders, I have not been able to find any exemptions written any place for cases like ours and I have not been able to find anyone familiar with this type of situation since we don’t make the 2 year rule, we are just shy of that.

A 1031 exchange is only available for rental properties, so you can’t use it to sell your primary residence and purchase a new primary residence. You could have used the proceeds from your sale this summer to purchase a new investment property, but you can’t do that retroactively. The process must be identified early and the money must never touch your hands.

However, you may not have any capital gains on the sale of your properties because you’ve owned your properties for such a short period of time. Unless you’re in markets that are appreciating extraordinarily fast, by the time you deduct all the sales costs, you’ll be lucky if you don’t have a loss on the sale. At the very least, your capital gains probably will be very small. I strongly recommend you meet with a realtor to get a good guesstimate of your home’s sales price and the net proceeds (sales price minus the costs to sell), then meet with a CPA that understands real estate and the military to go over the numbers and figure your best strategy BEFORE you file your 2017 taxes that include the sale of your Ohio property.

There may be a partial exemption if you are required to move for a job. The details are explained pretty clearly in IRS Pub 523, Selling Your Home. Honestly, this is a pretty basic question and if your CPA can’t answer it, you may want to question their understanding of capital gains rules in general.

Hi Kate! We just got back from HRBlock, and found that we will be taxed on our capital gain from our TX home. I just want to run our situation by you to make sure this is accurate.

Bought home in TX Sept 2012, received orders to PCS to MD in July 2013. We then rented out our TX house to another military family for nearly a $1000/mo loss compared to what our monthly mortgage payment was (it’s a long story, but it was for our piece of mind having friends in our house). They rented until Dec 2016, then we listed the house for sale and it sold March 2017 with a profit of 71k.

Would we be able to claim any type of exemption for the tax on the capital gain of $71, 000, since this was due to PCS orders?

Kristin, you’ve got a somewhat complicated situation here and I want to be 100% sure that you are getting the right information. While I am a trained tax preparer (just like the folks at H&R Block,) I am not a tax professional and my knowledge is only so deep.

You may be eligible for a pro-rated exemption on the capital gains based upon the fact that you moved due to PCS orders. IRS Publication 523 pretty clearly lays out the situations in which you may be eligible for a partial exemption and your details seem to fit. You don’t even need to delve into the military extension because the whole process occurred within the regular 5 year window, so most tax folks should be able to handle this.

BUT, you may special issues because you were renting at a loss. This is definitely delving into stuff that requires someone with a much deeper understanding of tax law. I highly recommend you find an Enrolled Agent or tax accountant and not rely on H&R Block to get this right.

You also have to deal with the depreciation recapture for the period of time that the house was rented, so many sure you understand how that works. That may be a significant portion of your tax liability.

This stuff is tricky but the more you know, the more you can have intelligent conversations with your tax professional and feel confident that everything has been done correctly.

Hi. My wife and I are dual military and we bought a house in Virginia in June 2012. We were due to transfer in Feb. 2017 so we started renting the house out in July 2016 to avoid that headache prior to transferring. Unfortunately, our initial orders fell through and we ended up staying in VA until June 2017. We have been renting the house ever since and are thinking about selling it this July 2018 in order to avoid paying capital gains tax. However, based off of what I am reading here, my understanding is that I can wait to sell my house in VA until around 2030 and still be exempt from capital gains tax? Please correct me if I am misunderstanding this and provide me correct information. Thank you!

Jason, don’t make any decisions based upon what I say, but rather read the regs yourself. They’re pretty clear in IRS Pub 523, Selling Your Home. I find that most people understand the most after the read and sketch out the examples provided rather than just reading the text. There are also examples in IRS Pub 3, Armed Forces Tax Guide, but I find that the examples in Pub 523 are better.

Kate,
My husband and I purchased a home that we only lived in for ONE year before we got transferred (military) and have been renting it out for the past 11 years. We now want to sell it, but most likely it will sell for LESS than what we originally purchased it for. If it sells for less than what we bought it for, will we owe any capital gains? I am confused if the proceeds from the sale would be considered a “gain” since the rental income has been helping to pay down the mortgage all these years. Or is a “capital gain” solely figured from looking at the selling price vs the original purchase price (and rental income is not a factor). Please set me straight on this.
Also, will we be penalized with any additional taxes due to the property being purchased as our primary residence, but then we only ended up living in it for 1 year?
Thanks for your help,
Carrie

Carrie, you’ve got a complicated situation that combines three different issues. First is the fact that you didn’t live in the house for the full two years to get the full capital gains exemption. (Though that may not matter.) Second, you will be using the military extension on the capital gains exemption. Most importantly, though, is that you’re probably going to owe significant depreciation recapture taxes, even if you sell at a loss. I am not a tax professional so while I can help you understand the rules, I can’t help you apply them to your specific situation. You’re going to need a very good CPA who thoroughly understands the military exemption and depreciation recapture. Start by reading this article, particularly the example at the end, and come back with your next questions! https://www.katehorrell.com/understanding-depreciation-recapture-taxes-on-rental-property/

I purchased a home in 2003, lived in it until 2010, when I PCS’ed with my military husband. Since we met after I owned the home, he was not on the loan or the deed. We rented the home for 7 years then returned to the US with a large family that required us to start fresh with a larger home.

I claimed the loss each year on the rental (rent was less than payment), then we lived in it roughly two months while we fixed it up, then purchased a new home and sold this one. Can I claim it as a sale of a main home? I definitely meet the time requirements and we actually lost a few thousand on the sale.

Laurie, I would recommend you meet with an Enrolled Agent or experienced tax CPA who understands the military extension (suspension) on the capital gains exemption. From the information you’ve give, it sounds like you will be clear of capital gains taxes but will owe depreciation recapture taxes. You need to sit down with a professional to go over your exact situation.

Hi Kate~
I really would like your opinion on our situation: (Our CPA says we owe a little over $60K in capital gains but with no answer as to why we don’t qualify for the military extension/suspension)
We bought our home in mid Sept 2002 and my husband PCS’d unaccompanied in late Oct2004 and returned back to the home through Nov2005. We then PCS’d to South Korea from Feb2006-Dec2007. From there I returned to the home and he PCS’d unaccompanied through Mar2010. (We divorced in 2008 but kept the home. I moved out and we rented it out through late July2017; Sold it Jan2018.) From March2010-present (he retired after 30 years) and immediately went to work with National Defense (Dept of the Navy) in DC.
Do you think we qualify, at minimum, a partial extension? He lived in the home over the two year requirement and both as active duty and his DoD required him to move over 50 miles away from the residence.

Thanks for posting all of this. I have a question about two exclusions in one year. I had a house in Charleston, then moved PCS to Georgia. I then separated while in the Georgia house. I lived in the Georgia house for 2 out of the last 5 and sold it and the Charleston house in 2017. If I am permitted to have two exclusions in one calendar year I do qualify for the 2 in 10 for the Charleston house and the 2 in 5 regular exclusion for the Georgia house. Is this permitted?

Please expand on military suspension rule for my situation. I purchase in Massachusetts Dec 2004; moved on orders to Ohio in Aug 2009; moved on orders to Florida in Mar 2011; retired in Florida in Dec 2014. Can I claim the military suspension on the Massachusetts purchase? If yes, is the last possible sale date Aug 2022 (to avoid Capital Gains Tax? Thereby showing it WAS my residence Aug 2007-Aug 2009 (suspending Aug 2009-??? … this is where I get confused…HELP.

Monica, you fall into a great big grey area because of your retirement. The IRS states that the exemption “can apply to taxpayers that have recently left the military.” https://apps.irs.gov/app/vita/content/globalmedia/4491_capital_gain.pdf Page 11-18, the first highlighted block But, I can’t find a definition of “can, nor “how long” into retirement the military extension could extend. I strongly suggest you meet with an Enrolled Agent or tax CPA who thoroughly understand this stuff and map out a plan that seems most likely to meet the rules. If it were me, I would be considering selling ASAP, or accepting the fact that my two exit strategies were either a) probate, or b) a large tax bill that included both capital gains and depreciation recapture.

I’d see about filing amended returns as far back as you can. (Note: the rules say 3 years, but I’ve heard of folks having them accepted up to five years back.) Depreciation recapture is based upon depreciation that was “allowed or allowable,” meaning you’ll pay the taxes on the depreciation even if you didn’t take it.

My wife and I purchased a home in Colorado in 1988, rented it out til 1992, and then lived in it for eleven years from 1992-2003. In 2003 I took a job as a contract civilian psychotherapist working with our troops at a military Mental Health Clinic on an American military base in Germany. I continued working at this clinic until I retired in May 2017 and we returned to Colorado. We rented our Colorado home out during our 13 1/2 year absence but have now been living in it again since June 1, 2017. Do you think my contract service overseas would qualify us for a capital gains exemption if we sold the house before residing in it for two years even though I was a contract clinician, not an active duty member of the military?

Follow-up question. I purchased property in July 2009, and lived in it until July 2012. I converted the property into a rental beginning August 2012. I received PCS Orders from the government to work overseas and subsequently I disposed of the property in September 2017.

I am a civil servant, with the DOD, DON. I am on official government orders and my questions are these:

1. In your experience, does Publication 523 include civilians on official government orders as “military”? Since I am overseas, I live in government housing and for all intents and purposes am considered military. I have access to commissary, medical and other “military” services due to my government orders. I know Richard (above) is a “contractor” and doesn’t have the same entitlements as those who receive official PCS orders.

2. Prior to receiving my orders in April 2016, the property was a rental due to me moving for a job (with the government, not on orders, not overseas). Since I sold in September 2017, if the exclusion extension does apply, do I simply go back 15 years from 2017? If so, it appears I would only need to have lived in the house 2 years between 2002 and 2017.

My main question involves the term “military” and “foreign service” in the Publication. I carry AFSPA Heath Insurance (American Foreign Service Protective Association). Thanks in advance for your help and assistance.

I suggest you meet with an enrolled agent or a tax attorney. It had never occurred to me that “military” might possibly mean anything other than someone who is on active duty in the military, nor that “foreign service” might possibly mean anything other than someone who is employed by the Department of State as diplomatic or consular personnel. In my non-professional opinion, you’re grasping at straws, but a tax professional may know some loophole that I’ve not encountered.

What about when you’re forced to PCS without warning? I bought a house, had a surprise PCS 10 months later, rented it out for a year and a half, then sold it because I wasn’t coming home. Thanks! Laura

This happens all the time, and it is one of the risks of buying a home while on active duty. There is a pro-rated exemption if you have a capital gain, which would be pretty darn lucky considering your short timeline.

We bought our home July 2016 and close May 2018 due to PCS orders. We are selling our home for roughly 40k more than the purchase price. Are we exempt or are we going to get slammed with CGtax? Any ways to decrease it (upgrades to the home etc)

Erica, depending on your specific situation, $40 more in sales price may not mean that you have any capital gain. You will deduct many of your selling costs from that number in calculating your capital gain. Then, you should be eligible for a pro-rated capital gains exemption. Lastly, I’m not sure why it would make more sense to put a lot of $$ into a house just to avoid paying a small capital gains bill. I’d run through your exact scenario with a tax professional before making any decisions.

The point I was making about the $40,000 is that even if the house “sells” for $40,000 more than you bought it for, you will probably see only a small fraction of that amount. For example, the last house I sold had a sales price of $454,000. On that, we paid about $24,000 in real estate commission, plus a bunch of various assorted local area transfer taxes and other settlement costs – in excess of $30,000 total. This amount would be considered when figuring the capital gain, so even if the house had sold for $40,000 more than the buying price, our capital gains amount would be less than $10,000. Does that make sense?

Can you explain the prorated capital gains exemption? I’ve read all the comments and I’m just not understanding it or how it works. We lived in our house for 17 months, sold for $50k over paid and look to pocket $29k. Do we pay taxes on the $29k based on a 17/24 month proration?

I purchased a home in March 2012, received active duty orders with a report date of July 31 2012. We lived in the house 4.5 months only. We had to rent it due to the short notice order and are just now getting ready to sell (this fall, 2018). We will have owned the hose for 6.5 years, lived in it for 4.5 months, and have rented it for 6 years. It sat vacant August, September of 2012, with renters beginning September/October timeframe 2012.

So, I don’t meet the 2 year rule, and I’ve owned it for 6.5 years. I don’t recall claiming depreciation, but did include the rental income expenditures (repairs, management costs, and insurance) in my tax filings each year it was rented.

You will be subject to capital gains, though you may be able to do a small pro-rate for the 4.5 months that you lived there. You will also be subject to depreciation recapture, whether you claimed depreciation or not. The law states “depreciation allowed or allowable.”

I strongly recommend a smart CPA. We sold a house last year and despite the fact that I understand HOW this law is applied, I had a lot of difficulty understanding how it works on paper, even with my CPA explaining it to me.

Hi! Im planning on selling my home in Hawaii next year and trying to figure out what income and capital gains tax I’d be liable to pay.

I’m currently in the military and bought my home in 2010 and moved to California in 2015 due to a military PCS. It has been rented out since then and I bought another home in California. This year, I had another PCS to another part of California and im currently renting. Both homes are now rentals.

I would like to sell the house in Hawaii next year (2019) but worried of the type of loss from capital gains tax. Would I still fall under the exemptions? Someone informed me that I would not since I rented the property out. I have been stressing since I was informed this but the source is not too credible.

Based upon the information you’ve provided, you would be exempt from capital gains. I base this on the 2-out-of-5 rule (you lived in the house from 2013-2015, out of the period 2013-2018, plus the military extension would cover the time from 2018-2019. Does that make sense to you?

Hi. I hope this post is still active. I undestand the application of this rule except for one point. Do I need to sell the house while still on active duty, or does the exclusion still apply after I retire?

That’s a tricky question, Shane. Once upon a time, the IRS had a Volunteer Income Tax Assistance training online on this subject. It specifically said, “”This extension of time can apply to taxpayers who have recently left the military.” It didn’t specify what it meant by “can” and “recently,” so it was only a little useful, but it was useful. However, that training has been moved around and now I can’t find that language anymore. That page gives you a 404 error.

There’s no reason to believe that the rule has changed, but I can’t find it written anywhere.

What should you do with that information? I can’t tell you that. I think you’ll have to make an individual decision based upon the specifics of your situation.

Hi Kate. I have a questions about partial exclusion of the capital gain after accounting for the 10 year suspension. Purchased a house in 2001. Lived in it until 2005. PCSed in August of 2005 and rented the property. Sold the property an the end of September 2018. After accounting for the 10 year suspension I am shy by a month meeting the 24 month residency period. Can I claim a partial exclusion for the qualifying period?
Thank you for your input.

We bought our house in November 2005. We lived in it through January 2008, but my husband was deployed from July 2006 through September 2007.

We moved back to our house in July 2009 and lived in it through July 2011, but my husband was deployed from September 2009 through July 2010.

So… I was originally thinking with our qualified suspension of residence that we had until July 2024 to sell the house and still qualify for the exclusion of gains, since we lived in it for those two years.

But I am concerned – does my husband’s deployment qualify as him “living in” the house or not?

If not, can we just use $250K worth of exemption since I lived in the house from July 2009 through July 2011? We won’t be making more than that anyway.

If we can’t do that, can we piece together his time living in the house? So, 13 months from July 2010-July 2011 plus 2 months from July 2009-August 2009 plus 4 months from October 2007-January 2008 plus 5 months from February 2006-June 2006? Meaning we would need to sell by January 2021 to qualify?

Hi Kate,
I think you’ve done an incredibly valuable service here. I have a related question to one many folks are asking, but I’ll make mine a bit more generic in hopes of helping some other people out. Here’s the scenario:

My family and I live in a house for 2+ years. We get orders to move. We rent the house. Fast forward several years, when we decide to sell. Based on the IRS verbiage, we qualify for the full tax exclusion (we’ll say $500K for a married couple). So for the sake of easy math, let’s say it’s a $100K actual capital gain. My question is, what is the net implication on the tax return that year? I realize the $100K is not taxed via capital gains since it’s less than the $500K threshold, but are there other implications? For example:

1) Since it was rented, do we get taxed on the depreciation recapature? Or no, since even that wouldn’t add up to $500K? Or is the depreciation recapture a different animal, and if so are there other caveats to using it as a rental (since that’s the primary use we’d all have for a house we no longer lived in)

2) Does the extra income via the capital gains count towards our AGI? In other words, could a huge gain even if excluded from tax, still bump AGI above thresholds (like no longer allowing them to contribute to Roth IRAs that year because they “made” too much), etc.?

3) I can’t think of anything else at the moment, but basically I’m just trying to figure out what other significant implications a home sale would mean on taxes, even if the full gain met the exclusion.

Hi Eugene – we were in your exact shoes in 2017, and I learned a lot that year. Yes, you will still owe depreciation recapture unless you actually lost money on the house. And yes, that depreciation recapture counts towards your AGI, which can have second and third order effects. (In our case, we’re having to go back and explain to colleges that we didn’t actually make that money in 2017, rather we just paid taxes on it in 2017.)

I strongly suggest you get a good Enrolled Agent or tax CPA to do this for you, and talk you through the process. Even understanding the law and the concepts, I found the forms a little confusing the first couple of times I read them.

Thanks for the quick response. I think your advise is valuable, definitely worth the cost of a tax CPA (not just a preparer). For me though, we’ll likely sell this summer, and I’m concerned the depreciation recapture is going to bump us over the roth ira income limits so I’m holding off on contribution to a roth this year like we’ve typically done in the past until I sit down and run the numbers. The depreciation costs are fixed, so I (or a CPA) should be able to figure out that number.

I just stumbled onto your blog, and I’ll repeat that I think you’re providing a wonderful resource for military members. I’m not sure if you’ve got a post on this topic yet, but if not it may be worth discussing at some point. Basically, a family makes too much money to contribute to a Roth. What to do? Right now (2019) the threshold is $193K of income when the Roth phase out begins, and by $203K a family can no longer contribute to a Roth. Seems like a crazy amount of money, but if members sell a long term rental (like in my case) and have tons of depreciation gain that will “act” as income (I think). If a member takes a huge signing bonus, that can bump families up one year, especially if the member is not married or is filing single. Anyway, a backdoor Roth is an option, and something my family and I figured out the hard way a few years ago after never thinking we’d ever make too much money to have to worry about income limits. It was a one time thing, but I learned a lot from that experience and will make it much easier to strategically plan for our “backdoor roth” this year as I think our rental is going to push us into a much higher income bracket than we’d normally be in.

Anyway, probably not a problem for 99% of families, but anyone that has a major event one year (bonus, rental sale, etc.) may run into the same issue so something worth thinking about. Like you said, probably the best advice anyone can give is to spend a little money meeting with a CPA, etc. before any of this happens. And I’ll reiterate a tax professional is whom folks should be seeking out, not a tax preparer (think H&R block rep at the BX come tax season). These scenarios are typically way too complicated for the average tax preparer. Thanks again for the discussion.

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